Working Paper: NBER ID: w14054
Authors: A. Craig Burnside; Martin S. Eichenbaum; Isaac Kleshchelski; Sergio Rebelo
Abstract: We study the properties of the carry trade, a currency speculation strategy in which an investor borrows low-interest-rate currencies and lends high-interest-rate currencies. This strategy generates payoffs which are on average large and uncorrelated with traditional risk factors. We argue that these payoffs reflect a peso problem. The underlying peso event features high values of the stochastic discount factor rather than very large negative payoffs.
Keywords: carry trade; peso problem; currency speculation
JEL Codes: F31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| peso problems (I32) | average payoff to the unhedged carry trade (G19) |
| peso events (F31) | expected payoffs (J33) |
| peso events (F31) | average risk-adjusted payoff to the unhedged carry trade (G19) |
| hedged carry trade (F31) | average payoffs (J33) |
| average risk-adjusted payoffs (hedged) (G40) | average risk-adjusted payoffs (unhedged) in non-peso states (G19) |
| high average payoff of the carry trade (G15) | risk associated with peso events (F31) |
| traditional risk factors (G22) | average payoff to the carry trade (G15) |